Euro Fizzles As Interest Rate Outlook Offsets Increased Risk Appetite From China's Fiscal Stimulus Plan

The Euro rallied as high as 1.2900 on momentum from increased risk appetite on the back of China’s announcement of a $586 billion fiscal stimulus plan. However, the psychological resistance level proved formidable as the declining interest rate outlook for Europe remained a weighing factor for forex traders.

Talking Points
• Japanese Yen: Fails At 99.50
• Pound: Producer Prices Slowest in 22 Years
• Euro: Investor Confidence Drops To Record Low
• US Dollar: Risk Appetite To Dictate Dollar Direction

Euro Fizzles As Interest Rate Outlook Offsets Increased Risk Appetite From China’s Fiscal Stimulus Plan

The Euro rallied as high as 1.2900 on momentum from increased risk appetite on the back of China’s announcement of a $586 billion fiscal stimulus plan. However, the psychological resistance level proved formidable as the declining interest rate outlook for Europe remained a weighing factor for forex traders. The economic calendar showed further evidence that the region’s economy is entering into a recession as industrial production fell in September for both France and Italy. French activity dropped 0. 5% for the month which dragged the annualized pace down to -1.9%, as automobile output slumped on waning demand. Meanwhile, Italy saw a sharp 2.1% decline in industrial production in September and a 5.7% drop year-over-year. The dour outlook for the economy has sent the Euro Sentix investor confidence to its lowest level on record at -36.4 after a -27.6 reading in November.

The expectations that the ECB will lower rates again received a boost when President Trichet in a recent interview confirmed that inflationary pressures were easing as the region’s economy headed into a recession. Although the central bank leader would reiterate the MPC’s price stability mandate. However, with the downside risks to inflation increasing, lowering interest rates may be the required measure to ensure price stability. As deflation becomes a concern we may see the ECB start to aggressively cut rates and follow the lead that was set by the BoE last week. The Euro could find support this week on the increased risk appetite as the Chinese fiscal stimulus plan combined with the recent talk of interest rate cuts from the developing nations in the G-20. However, resistance lies ahead sat 1.3000 where the psychological level is reinforce by the 20 Day SMA, followed by the November 5th high at 1.3116. Ultimately, we may see the single currency remain in its recent range of 1.2500 – 1.300 before weakening as we get closer to the next policy meeting on December 4th.

The Pound like the Euro failed to break psychological resistance at 1.5900 on the back of the Chinese fiscal stimulus plan. The BoE’s recent 150 point slash of its bench mark rate was due in part to deflationary concerns. The U.K. producer price index reading for October confirmed those concerns as they fell at the fastest pace in 22 years. Input costs dropped 5.6% on the back of declining oil prices which translated into a 1.0% fall in factory gate prices. As manufacturers cost continue to drop more savings will be passed onto consumer s and the country will start to experience a sharp declines in inflation. Therefore, we may continue to see the central bank lowering interest rates to as low as 1%. The expected declining interest differential will remain a weighing factor on the pound

An empty U.S. economic calendar will leave the dollar at the mercy of risk winds, which could see it weaken as risk appetite has been fueled by the Chinese fiscal stimulus plan. The financial aides p[package which will be the largest in the country’s history and equal to 1/5 of its GDP will help generate growth in the fourth largest economy in the world. The measure has improved the outlook for global growth which could fuel the carry trade as high yielding currencies become more attractive. Therefore, the dollar could weaken as it has become a funding currency with interest rates at 1%. Yet, the dollar continues to remain firm despite the dismal Non-farm payroll report that saw the country lose 240,000 jobs and unemployment rise to a 14 year high of 6.5%. The dollar may weaken throughout the week with very little event risk ahead until Friday’s consumption report as traders grow confident.

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To discuss this report contact John Rivera, Currency Analyst: jrivera@fxcm.com